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Fed to look past emerging-market woes, hike rates again

The U.S. Federal Reserve is expected to raise its benchmark federal funds rate June 13, looking past uncertainty elsewhere in the globe and requests from some if its counterparts that the Fed be patient on tightening.

The Fed's move would put the target range for the federal funds rate at 1.75% to 2%, marking the seventh rate hike from the central bank since 2015 and the second one this year.

The action would come amid improved optimism over the U.S. economy, with the country's unemployment rate falling to 3.8% in May and consumer confidence levels rising. Fed officials have so far stuck to their plan to gradually hike rates, with some beginning to say they see themselves moving to a "modestly" restrictive path in the future.

But the Fed's moves are reverberating in emerging markets, which have seen sell-offs and their currencies drop as U.S. interest rates keep rising and the Fed's balance sheet roll-offs continue. The most prominent examples are Argentina and Turkey, where leaders have taken aggressive action to prevent their currencies from falling further, with Turkey doing so again last week. Central bank officials in India and Indonesia have also hiked rates and cautioned the Fed to take developments abroad into account, according to Bloomberg News.

Fed Chairman Jerome Powell has downplayed the issue, saying last month the role of U.S. monetary policy is "exaggerated" and that rising rates "should continue to prove manageable" for emerging markets. He also has given little indication that the Fed will stray from its current path.

"The question really is: Which is more important, moving towards rate normalization … or just holding back and letting the world dictate what the Fed does?" said Quincy Krosby, the chief market strategist at Prudential Financial.

Other elements are clouding the global outlook. Uncertainty over the new government in Italy has led to U.S. market downturns in recent weeks, while some analysts also worry about the potential that tariff discussions will escalate further and significantly damage the economy.

But the Fed will for now largely be "focused on what's happening here domestically," said TD Ameritrade's Shawn Cruz. The U.S. GDP outlook for the year is improving due to recent positive economic data, he noted, and the U.S. labor market is getting even tighter as job openings continue to rise. Optimism among U.S. small businesses also increased for the 18th straight month in May.

Meanwhile, inflation figures shot up in May and rose at their fastest annual pace since February 2012, according to the latest Consumer Price Index data. The headline inflation figures strengthened to 2.8% year over year in May, up from April's 2.5% reading.

The Fed's preferred inflation gauge is hovering just below the Fed's 2% target after years of substantial undershoots, with April's figure remaining unchanged at 1.8%. A number of Fed officials have said inflation will likely overshoot the Fed's target a bit in the coming months — and have indicated they are not worried about that scenario.

Fed watchers are awaiting the latest round of quarterly projections to see whether the U.S. central bank plans to increase the pace of rate hikes. When the Federal Open Market Committee last put out its projections in March, Fed officials suggested they still favor three rate hikes this year but came close to signaling a fourth would be appropriate.

"The slow but steady upward pressure on inflation" could prod Fed officials into penciling in four moves this year, Doug Porter, chief economist at BMO Capital Markets, wrote in a note to clients.

As the Fed continues to tighten, it is edging closer to what it views as a "neutral" rate of interest — one that neither helps to encourage nor to dampen economic growth. That has sparked internal discussions on whether the central bank should adjust its post-meeting statement and remove the portion indicating the Fed plans on stimulating the economy "for some time."